1
MICROFINANCE:
FINANCIAL SERVICES FOR THE POOR
Siddharth Parameswaran
(FIAA, ASIA)
Nicholas Raper
Presented to:
The Institute of Actuaries of Australia
2003 Biennial Convention
Shaping the Future: In a World of Uncertainty
18-21 May 2003
© 2003 The Institute of Actuaries of Australia
2
MICROFINANCE: FINANCIAL SERVICES FOR THE POOR
Microfinance is an economic development approach that involves providing financial services through
institutions to low-income clients, where the market fails to provide appropriate services. The range of
products provided by the microfinance institutions (MFIs) includes credit, savings and insurance services.
In many cases, the microfinance institution might provide social intermediation services as well, such as
training and education, in line with their development objectives.
The rationale behind the establishment of microfinance schemes is that access to financial services is a key
component of empowering the poor. Improved access to and efficient provision of savings, credit and
insurance services can enable the poor to smooth their consumption, manage their risks and invest in
themselves in order to improve their quality of living. A lack of access to adequate financial services is one
contributor to a lack of development opportunities and a cause of hardship for the very poor.
What this paper covers
This paper has three goals:
•
First and foremost, to explain to actuaries what microfinance is;
•
Secondly, to explain what are some of the important (and unique) issues facing microfinance
institutions in doing their work; and
•
Thirdly, highlight areas where actuarial skills may be used.
In the authors’ views, there is scope for actuaries to use their financial management skills, and
their knowledge of financial products in this field. Microfinance providers face a dearth of
financial skills in their staff. This need must be tempered with the reality that the non-profit
nature of most of the programmes, and lack of data make it difficult for the schemes to employ
and make use of financial professionals adequately.
Having explained what this paper aims to cover, it is also worthwhile spelling out some of the important
issues in microfinance that we do NOT cover.
Firstly, the discussion on microfinance is limited to its provision in third world countries. Similar schemes
are being tried to aid disadvantaged communities in the developed world as well. Many of the issues faced
by those schemes are sufficiently different to the developing world to require a separate discussion.
Secondly, it is not in the scope of this paper to discuss the extent to which microfinance reduces poverty
when compared against other needs like health and education. Suffice to say, the need for microfinance has
to be considered against these other competing needs of the poor. There seems nevertheless to be agreement
amongst development agencies that in many contexts, it can be a very useful tool to aid the poor.
Thirdly, this paper does not provide discussion on what is needed to have a “successful” scheme. It discusses
important trade-offs to consider, rather than providing definitive solutions. Neither of the authors have a
background of working with microfinance institutions, and hence do not feel comfortable providing advice
or judgements on policy.
3
Section 1: What is Microfinance?
1.1. Definition:
Microfinance is an economic development approach that involves providing financial services through
institutions to low-income clients, where the market fails to provide appropriate services. It involves
providing the poor with access to savings, insurance and credit services. This will enable them to
smooth their consumption, manage their risks better and invest in themselves in order to improve
their quality of living.
1.2. Brief History:
1.2.1.
Microfinance products are variations on financial services products that have been in
existence for many years.. Access to some form of financial services, usually on an informal
basis have been around in the developing world for a very long time. For example, there were
the credit and savings groups such as the “tontines” in Africa, and the “tandas” and “pasanaku”
in Central and Southern America. These funds were community based structures supporting
and providing limited services to the people of the tribe.
1.2.2.
Access to financial services institutions is much more recent. Institutions bring scale, and
more rigour into the provision of financial services. Such institutions have been around in
Europe from at least as far back as the 15th Century (e.g. the Medici family of Florence).
Banking however grew most rapidly during the times of the industrial and agricultural
revolution from the 1700s onwards. Banks provided credit services to the richer / more credit
worthy segments of society.
1.2.3.
Financial services that targeted the poor exclusively did not emerge in Europe until the
early 1700s when Jonathan Swift started the Irish Loan Fund system. Here, funds were
provided as small loans to farmers and other rural clients who lacked the capacity to borrow
money through more traditional means, and often required working capital to conduct
business efficiently. These funds proved very popular amongst the rural clientele and by the
1800s there were about 300 funds throughout Ireland providing similar services. From this,
various other types of institutions targeting the poor also sprang up (e.g. friendly societies).
1.2.4.
In the developing world, institutional financial services for the poor can be traced back to
state credit co-operatives that were set up between the 1950s and 1970s. These schemes were
set up in many countries to assist particular industries (most often agriculture). They involved
providing training, coupled with cheap credit. Some of these schemes however suffered due to
low repayment rates and corruption.
1.2.5.
As a response to this problem, and due to a need to provide financial services beyond purely
the agricultural sector, the microfinance industry arose in force in the 1980s. Non-government
organisations (NGOs) primarily established credit schemes to provide finance to various
sectors. They often provided these services as part of a strategy to achieve broader goals, such
as empowerment of women. Donor organisations were an important part of the microfinance
scene by providing the seed capital that has allowed the provision of loans, often with
subsidies to offset defaulting on loans by recipients of the services.
1.2.6.
There are now many participants in the microfinance scene. These include NGOs,
development agencies, governments and even private companies. The growth over the last few
decades has in fact seen the emergence of many larger microfinance institutions. Institutions
such as the Grameen Bank in Bangladesh have started to provide credit on a large scale to
poorer clients who are unable to access traditional financial services. There has been a trend in
the last decade towards MFIs trying to achieve financial sustainability, rather than just
4
relying on donor funds for subsidies
Box 1.1- Microfinance Institution: Grameen Bank
The Grameen Bank in Bangladesh is probably the best known microfinance institution.
It serves the poor in Bangladesh by encouraging them to borrow and save in a
financially responsible manner. The origin of Grameen Bank can be traced back to 1976
when Professor Muhammad Yunus, Head of the Rural Economics Program at the
University of Chittagong, launched a research project to examine the possibility of
designing a credit delivery system to provide banking services for the rural poor. Since
its small beginnings, the bank has distributed almost $US3bn of loans and has an
outstanding loan portfolio of $US218.19m at Dec 2002.
Box 1.2- Microfinance Institution: Bank Rakyat Indonesia
The Bank Rakyat Indonesia(BRI) is one of the largest microfinance institutions. It is
one of the few MFIs that is financially self-sufficient, and with substantial outreach
across Indonesia. In Oct 2002 BRI had 30 million customers across the whole of
Indonesia. The value of the outstanding loan portfolio was $US1.319bn. BRI holds
over $US2.5bn of savings from 28million poor and rural customers.
Microfinance provided in a sustainable way is now seen by both the World Bank and the Asian
Development Bank as one important tool for poverty alleviation around the world.
1.3. Products and services provided by Microfinance Institutions
1.3.1.
Types of services: As MFIs are set up with the aim of poverty alleviation in mind, they often
provide more than just financial services. The three main types of services provided are:
1.3.1.1. Financial Intermediation: This is the main service offering of MFIs (and the focus of this
paper). It can include providing working capital, fixed asset loans, savings and insurance
products.
1.3.1.2. Enterprise Development Services: As a complementary service, some MFIs offer a basic
level of training to encourage successful microenterprises. This can ensure a better
success rate in the impact of the credit provided. This may involve training on marketing
and business management etc.
1.3.1.3. Social Services: Where social services are very poor in an area, it can be difficult to
provide financial services that people will be able to use. The people may be living handto-mouth, without any basic social services being provided. It can be very difficult for
people under such circumstances to engage in sustainable entrepreneurial activities.
Basic social services that could be provided by MFIs, before provision of financial
services can include assistance with health and education. Such services obviously
require substantial donor funds to operate. They are however far more important than
financial services to people that face such poverty.
1.3.2.
Financial Intermediation: We will mainly examine the financial services provided by MFIs, as
it is in these areas that actuaries might be able to provide most assistance.
Financial Intermediation involves transferring capital, liquidity or risk from those parts of the
economy that have a surplus, to those that have a shortage. MFIs are often not in a position to
provide a full suite of financial services. The products they do offer depend on their objectives,
and the needs of their target market. In principle, they are very similar to those offered by
large financial institutions, but usually with an emphasis on simplicity. Some of the products
provided by MFIs include:
5
1.3.2.1. Credit: Loans are usually provided for investment in a productive pursuit (as opposed to
being used for consumption). There are times (e.g. during a drought that causes a lack of
production), where the loans may be provided for consumption as well, although if used
too widely, it may result in a high rate of default. Credit is usually provided on a shortterm basis (anywhere between 3 months and one year), generally for small loan sizes.
Assessing credit risk is difficult, and not cost effective for small loan sizes. The method
used by most MFIs is to lend small amounts to individual customers at first. If they
make timely repayments, they will increase they amounts they lend in the future. Some
MFIs try to ensure repayment by forming Joint Liability Groups. These involve
members of a community agreeing to guarantee each other’s loans. This way, peer
pressure and community conscience can result in a high rate of repayment on loans.
MFIs are forced to run very cheap operations (e.g. few branches, a mobile staff force with
low salary expectations). Loan interest rates are usually higher than commercial banks,
due to the higher default risk and higher expense ratios faced.
1.3.2.2. Savings: Deposit taking services can be very valuable to the poor, who often have very
few reliable places to save money in order to smooth timing differences between their
income and expenditure. From the MFI’s point of view, it can be a useful source of funds,
and can encourage financial prudence in their clients. The risk in providing these
services are similar to those faced by any bank. If the MFI’s loan repayment rate in
particular is poor, there is a great risk that depositor’s capital will be eroded. Generally,
deposit taking institutions would be required to face much more regulation than those
providing just loan services. It can be disastrous for confidence in the financial system if
the poor lose their savings due to insolvency of the MFI.
1.3.2.3. Insurance: MFIs in some countries are trying to expand their product range to include
risk transfer services. The Grameen Bank in Bangladesh for example requires each
member in a group lending programme to contribute 1 percent of the loan amount to an
insurance fund to cover the risk of death mitigating their ability to repay the loan. Other
types of insurance offered include health and property. This is a risky product to offer for
many MFIs, as they often lack the expertise to price or control the risk they take on- did
somebody call for an actuary? It is also questionable whether insurance is of as much
value to the very poor, as the cost to transfer the risk may be too high for them. Some
institutions1 that have provided insurance say that clients get benefits from protection
against extreme hardship caused by death or catastrophe. Such disasters often hurt the
poor more than the rich.
Box 1.3- Microfinance Products: Grameen Bank
The Grameen Bank has developed a framework for loans that attempts to encourage responsible financial
practices amongst their clients. This is achieved by requiring all loan recipients to have partaken in a
regular savings plan prior to receiving a loan, and through the continued education of their clients. The
Grameen Bank originally focused on providing its services to women, but has expanded its services to
other disadvantaged groups in society, and now provides both credit and deposit facilities to a large
number of people throughout the country.
1
“Health Insurance Services for Rural Households in Cambodia, Activity Report of Two Years of Experimentation”
Christine Poursat, Pascale Le Roy: GRET 2001
6
Box 1.4- Microfinance Products: Bank Rakyat Indonesia
Bank Rakyat Indonesia’s “Kuepedes” credit facility for small businesses is one of the best known
microfinance products worldwide. There are two different types of “Kuepedes” loans, a ‘Working Capital’
loan and a ‘fixed asset’ loan, each of which have slightly different terms and conditions, reflecting
different demands and risks. The “Kuepedes” products are explicitly not available as a source of venture
capital and are targeted towards micro businesses to help improve operating efficiency and promote
economic growth among the poorer and rural clients.
Working Capital Loan Product
Term: 24 Months
Minimum loan: Rp 25,000 (~$US3)
Maximum loan: Rp 50,000,000 (~$US5,000)
Repayments: 1, 3, 4 or 6 monthly
Prompt repayment incentives
Fixed Asset Loan Product
Term: 36 Months
Minimum loan: Rp 25,000 (~$US3)
Maximum loan: Rp 50,000,000 (~$US5,000)
Repayments: 1, 3, 4 or 6 monthly
Prompt repayment incentives
Maximum combined outstanding loan balance if two loans are held is Rp 55,000,000.
1.4. Whom services are provided to
1.4.1.
Clients of MFIs include self employed, low income entrepreneurs in both urban and rural
areas. E.g. street vendors, small farmers, service providers (rickshaw drivers, hairdressers) and
artisans.
1.5. Size of market
1.5.1.
1.5.2.
Official statistics on the size and scale of microfinance programs across the world are
extremely hard to find, and often unreliable.
The Number of MFIs and customers:
A survey conducted in 1999 by the International Food Policy Research Institute (IFPRI)
estimated that 54 million customers in Asia, Latin America and Africa were serviced by MFIs,
with outstanding loans of US$18bn and US$13bn in savings. A similar survey conducted
earlier in 1995 by the Sustainable Banking with the Poor Project indicated that MFIs reached
only 13 million customers, with outstanding loans of US$7bn. This shows that there has been
a rapid increase in the reach of MFIs in quite a short space of time. It must be noted however
that looking at these statistics, it is very hard to incorporate the large number of small savings
and credit groups that exist in Asia, Africa and South America. Perhaps some of the increase
can be explained by the greater reach of the second survey.
1.5.3.
1.5.4.
Nevertheless, it is clear from available statistics that MFIs are highly concentrated in size,
with the IFPRI survey showing that 80% of the customers are reached by just 3% of the MFIs.
The United Nations Capital Development Fund (UNCDF) estimates however that there are
more than 10,000 microfinance organisations operating in more than 42 countries across the
world!
Breadth of activities and size of loans:
Given the lack of comprehensive statistics on all the MFI operations around, we have focused
on the best source of information we could get on loan sizes by region. Box 1.5 and 1.6 below
demonstrate the break up of the USAID (the United States’s government foreign aid body’s)
microfinance portfolio. USAID directly funds many microfinance institutions around the
world. It can be seen that the majority of the operations are being carried out in Asia and
Latin America. This is likely to be typical of the entire industry in general, as these are the
continents where the programmes have had the most history of success. The large number of
loans issued, and clients served in Africa, is larger than we would expect for the industry as a
whole. African microfinance schemes have more of a chequered history, with some schemes
suffering low repayment rates, and some facing difficulty in breaching the cultural sensitivities
of providing loans to women. As can be seen from the tables, the average amounts outstanding
7
are not very large, with the average loan balance in Africa and Asia being under US$200.
Box 1.7 shows the Grameen bank’s average loan size.
Box 1.5- USAID Loan Recipients
Africa
Asia
Near East
Europe/Eurasia
Latin America/Caribbean
Total
Clients
(‘000s)
Clients
(% of Total)
Average Loan
($US)
315.3
625.5
88.7
14.6
28.9
4.1
193
179
498
148.5
986.4
2164.4
45.6
100.0
6.9
Female Clients
(%)
432
595
401
72
87
27
54
65
70
Source: U.S.Agency for International Development Microenterprise Results Reporting for 2000
Box 1.6- USAID Savings Clients
Clients
(‘000s)
Africa
Asia
Near East
Europe/Eurasia
Latin America/Caribbean
Total
Average Savings Account
($US)
952.7
792.8
3.2
193
179
498
147.9
1258.5
3155.1
432
595
401
Source: U.S.Agency for International Development Microenterprise Results Reporting for 2000
Box 1.7- Microfinance Loans: Grameen Bank
According to its website, Grameen Bank’s average outstanding loan was around US$110 in 2001
(15971m Bangladeshi Takas to 2.5m borrowers, exchange rate to $US of 60).
1.5.5.
Needs for finance that are currently being met: It is perceived by most people involved in
development activities in the third world, that the financial services industry fails to provide
services equal to those demanded by the world’s poor. Robinson in her book Microfinance
Revolution, 2001, estimates that there are approximately 1.8bn economically active poor in the
world. This is considered the target audience for microfinance institutions. The economically
active poor refers to the low to low-middle income earners that have some form of
employment, and hence income, and are not malnourished or severely food deficient. They are
the people that are capable of generating income to establish self sufficiency and economic
growth but for reasons beyond their control lack access to financial services to assist them in
their endeavours. The number of economically active poor and the demand for microfinance
services can be extensively debated, but all sides concur that they are substantial.
8
Section 2: What are some of the unique challenges faced by
microfinance institutions?
2.1.Understanding the country’s financial landscape:
In providing microfinance it is important for MFIs to understand the financial landscape of the
country they are in, both from the users’ perspectives and the providers’ perspectives. The
landscape in a particular country can greatly affect the strategy, and ability of MFIs in reducing
poverty. This section addresses some of the important issues for MFIs to consider.
2.1.1. Who are the existing financial services providers and what needs are they meeting?
2.1.1.1. In developing countries, there can be very varied providers of financial services.
Providers can include formal profit based institutions, such as private banks / insurance
companies, state based financial intermediaries (which may have less straight forward
profit objectives), credit co-operatives, MFIs and informal lending sources (such as
family, or local money lender). Each of the providers are operating in different
environments with varying client needs, profit aims, and degrees of regulation
protecting customers.
2.1.1.2. The types of products on offer can vary as well. For example, they may provide deposit
taking services, credit services, investment vehicles and/or insurance. Before
understanding what financial services needs are best met through a microfinance scheme,
it is important to understand what needs are already being met. Obviously, not all the
participants would service all markets with all products.
Box 2.1- Possible Financial Service Providers (reproduced from Microfinance Handbook, 1999)
Formal sector
Central bank
Banks
Commercial banks
Merchant banks
Savings banks
Rural banks
Postal savings banks
Labor banks
Cooperative banks
Development banks
State-owned
Private
Other nonbank institutions
Finance companies
Term-lending institutions
Building societies and credit
unions
Contractual savings institutions
Pension funds
Insurance companies
Markets
Stocks
Bonds
Semiformal sector
Cooperatives
Savings and credit cooperatives
Multipurpose cooperatives
Credit unions
Banques populaires
Cooperative quasi-banks
Employee savings funds
Village banks
Development projects
Registered self-help groups and
savings clubs
Nongovernmental organizations
(NGOs)
Informal sector
Savings associations
Combined savings and credit
associations
Rotating savings and credit
associations and variants
Informal financial firms
Indigenous bankers
Finance companies
Investment companies
Nonregistered self-help groups
Individual moneylenders
Commercial
Noncommercial
(friends, neighbors, relatives)
Traders and shopkeepers
NGOs
2.1.1.3. The extent to which informal financial services are provided are difficult to assess. They
can involve providing loans or deposit services to households in a village, often without
formal collateral. As the lender and the borrower usually know each other, social
sanctions within the community substitute for legal enforcement.
9
2.1.1.4. In rural areas, where there may be less provision of financial services, it is quite
common not to see the presence of for-profit financial institutions.
2.1.1.5. Government provision of financial services can have both good and bad consequences.
Experience in some developing countries is that if they operate inappropriately2, they
can severely distort the operation of the financial services sector. The World Bank
identifies that one of the most detrimental circumstances for the sustainable provision of
finance to the poor is when state banks undertake wholesale debt forgiveness. This can
lead to a view amongst borrowers from all providers that they are better off not repaying
loans, and instead waiting for the loans to be written off.
Box 2.2- Microfinance and Corruption
According to the World Bank, , there is also little point for banks to provide subsidized loans. It can lead to
inefficient allocation of loans, and can result in lower loan volumes than would otherwise be the case. The
World Bank suggests that within a certain range, poor clients are not very interest sensitive for loan
services, and hence are not as needing of interest subsidies as might be expected. The World Bank also
warns that subsidies can encourage corruption which can lead to an inefficient allocation of the subsidized
loans. This is because the more influential people in a community can crowd out access to the very poor.
A case in point is the government operated rural credit schemes in India. India's Agricultural Credit Review
Committee reported in 1989 that during the election years, and even at other times, there was considerable
propaganda from political platforms for postponement of loan recovery or pressure on the credit institutions
to grant extensions to avoid or delay the enforcement process of recovery. In the course of field visits, it was
often reported that political factors were responsible for widespread defaults on the ostensible plea of rural
crop failures. The "willful" defaulters were often politically important people whom the credit agencies'
bureaucracy was reluctant to touch. Their practices were often copied by the whole population in an area.
Banners were sometime put up in villages declaring that no bank officer should enter the village for loan
recovery purposes. The general climate, therefore became increasingly hostile for recoveries, and made it
difficult for the provision of further loans.
Source: Yaron, Benjamin, and Piprek, 1997
2.1.1.6. Government participation in financial services has of course been successful in poverty
reduction in some countries, especially where advantage has been taken of the wide reach
of governments. The loans can also be part of a broader policy of development, which
can include education that could enhance the usefulness of access to finance. The MFI
must be aware of the extent, nature and aims of government involvement in the financial
sector.
2.1.1.7. Understanding a country’s financial system can allow potential MFIs to identify areas
in which services or products are inadequate. It can also help them understand if
partnerships with existing providers may be an effective way of achieving their
objectives.
2.1.2. Who are the potential clients?
2.1.2.1. In providing a microfinance programme, it is important for MFIs to have a clear focus
on what market they are targeting (and why that market fits in with their overall
objective). Experience shows that well targeted schemes are much more likely to succeed
than trying to provide all products to all the poor in a country. Many MFIs restrict
themselves to clients that meet a particular poverty level, gender, ethnic group, caste or
region etc. This allows them to concentrate their resources in better understanding that
target market.
2
Microfinance handbook
10
2.1.2.2. It is important for MFIs to understand the extent of poverty in the country they are
operating in. This will aid in assessing the potential size of the market, and in designing
products and policies that are appropriate for the country. Understanding this issue will
help in better poverty reduction outcomes.
2.1.3. How do existing financial sector policies affect the provision of financial services, including interest rate
policies, government mandates for sectoral credit allocation, and legal enforcement policies?
2.1.3.1. Interest rates set by MFIs for their loans and for their savings products need to take
into account the rates of return on government debt (if anyone is willing to buy it at
commercial rates), as well as the rates of return in the mainstream finance sector (as
these are reflective of the opportunity cost of using the funds).
2.1.3.2. In some countries there may be interest rate restrictions (which provide a ceiling on
lending rates, in order to restrict profiteering). This can cause problems for microfinance
institutions, as they usually face higher default rates and higher transactions costs than
traditional finance providers. If such restrictions exist, this can place severe constraints
on the reach and sustainability of microfinance institutions. In some countries, the only
way MFIs could operate sustainably whilst targeting the poor was to lobby the
government to change the regulatory regime. In others, MFIs have instead been forced
to target financially more affluent clients, as they usually have better repayment rates on
loans.
2.1.3.3. Government mandates in some developing countries (e.g. India, Nepal), exist for
financial sector institutions to provide a certain proportion of their portfolio to either the
rural sector, or specifically the poorer sectors of society. Commercial financial
institutions are therefore forced to think about how to provide some services to the poor.
Often they may do this by allocating funds to microfinance institutions, in lieu of
providing their own services.
2.1.4. Legal enforcement of financial contracts:
2.1.4.1. Given that there will always be some defaults on loans, it is important to understand the
avenues available to reclaim from defaulters. In some countries, with appropriately
worded contracts, it may be possible to get the police to charge defaulters directly,
without needing to commence with court proceedings. Where property rights are less
clear, and less firmly enforced, it may be more difficult to pursue defaulters. Generally
traditional finance products require significant collateral before a loan is issued. This is
one of the significant differences with microfinance, where loans are generally issued
without collateral. Defaults on loans will therefore result in relatively large losses for the
lender.
2.1.5. Economic and Social Policy Environment:
These characteristics in a country greatly affect the ability of MFIs to provide financial
services, and the goals they may target.
2.1.5.1. Political stability: It is usually difficult to operate MFIs in countries subject to great
political instability. The higher risk involved in making financial decisions given this
instability will have to be passed on to the users of the financial products, if it is possible
to operate at all. However, from a development perspective, it is usually the places that
face the most upheaval that could benefit the most from the provision of donor capital for
lending services, to smooth the economic effects of the upheaval.
2.1.5.2. Economic Stability: Where there is economic stability, financial decisions can be taken
with more certainty. The following are necessary to consider when assessing both the
environment and the strategies needed for providing finance.
2.1.5.2.1.Inflation: This can erode the value of repayments on loans, and can generally
discourage saving. MFIs sometimes operate in countries where there are high rates
of inflation. Often the solution is to link loans to “hard currencies” (e.g. US dollar).
This can however open up even further risks for the MFI and clients to manage.
11
2.1.5.2.2.Interest Rates: As mentioned earlier, the policy of setting local interest rates will
influence the alternative uses of the MFI’s funds in the economy. An interest rate
charged on MFI loans should be taken at least with some reference to the policy
and level of rates on government and bank lending.
2.1.5.2.3.GDP growth levels give an idea of the opportunities in an economy for growth.
Countries that enjoy solid growth have more opportunities for new businesses, and
generally may have better success with microentrepreneurships (ceteris paribus).
2.1.5.3. Government Assistance in Encouraging Microenterprise: This assistance can take two
forms:
2.1.5.3.1.Investment in infrastructure and human resource development: For the successful
growth of microenterprises, it is very useful if there is investment in infrastructure
(such as roads, electricity etc) by governments to aid the smooth operation of
markets. Investment in education is essential as well. From experience, it is usually
areas with the lowest literacy rates that benefit the least from the provision of
microfinance services. People without basic education may not have the necessary
skills to operate a small business, save or manage credit.
2.1.5.3.2.Direct assistance, either through donor funding, or policy initiatives that
encourage the starting up of small businesses (such as easy legal administration,
tariffs etc).
2.2.Credit Assessment & Interest Rate Policy on Lending Activities
Lending services provided by MFIs are vulnerable to the risk of clients defaulting. Poor people
generally have few assets to fall back on in times of hardship, and MFIs can lose large proportions
of the loan balance if they default. Outlined below are some techniques used to manage this
problem.
2.2.1.
Limiting chance and extent of default:
2.2.1.1.
If the loan term and repayment schedule match the needs of the borrower, they
can reduce the chance of default. E.g. finance needs for investment in agricultural
production are likely to be more seasonal than investment in trading activities.
2.2.1.2.
Requiring some collateral or collateral substitute can reduce default. Usually,
collateral is something that the very poor do not have. Substitutes are often needed,
such as group guarantees (where members jointly guarantee each other’s loans),
character references (where loans are only made to those regarded well in a
community), or the threat of prosecution for non-repayment.
2.2.1.3. Accounting properly for loan losses: MFIs assess the quality of their loan
book through a “portfolio report”. A portfolio report involves tracking the various
statistics about the loan portfolio, including the volume of new loans, average sizes
of existing loans, and the size of loans in arrears. This is usually plotted over time
to see if there is any deterioration. An assessment of the recoverable proportion of
problem loans is necessary to ensure adequate financial control on the entity. A
failure to adequately assess loan losses can lead to mis-pricing of loans, and the
eventual collapse of the institution. Once loans are identified as being fully
unrecoverable, they should of course be written off straight away. It is important to
keep subsidies provided by donors to cover poor loan performance as an explicit
item in the accounts, so as to assess the underlying performance of the scheme
(without subsidies).
2.2.1.4.
Calculation of interest rates: Interest rates that are set need to account for the
rate of loss through default on the loan portfolio.
12
2.3. Regulation:
Regulation of financial intermediaries is designed to ensure solvency, acceptable customer
service standards, competition and confidence in the financial system. The standards in the
developing world can vary significantly in complexity and reach. Most MFIs do not operate
under the normal suite of government regulations for the formal financial sector. The issue
of regulation of MFIs is perhaps of less importance to a country if institutions mainly rely on
donor funds, and do not engage in deposit taking activities. As MFIs start relying more on
private capital to fund their loans, and view sustainability as a necessity, appropriate
regulation will be important to ensure trust in the sector.
2.4. Tension between sustainability and meeting development goals: Of the
estimated 10,000 microfinance institutions around the world the UNCDF (United Nations
Capital Development Fund) estimates that only 2% of these are financially self-sufficient.
The vast majority of MFIs rely on donor funding to subsidise their loan portfolio in order to
continue operations. While ensuring MFIs are self-sufficient would certainly increase supply
of services, it may mean that the poorer segments in a country (i.e. the sectors that need the
most help in developing) may not be serviced. The poorest segments in a country are
innately the riskiest to lend to. A trade off is needed therefore between achieving financial
sustainability and reducing poverty.
2.4.1. Development Objectives that are targeted by MFIs:
MFIs typically try and service the financial needs of unserved markets as a means of
reducing poverty. The development objectives they aim for could include the following:
• To reduce poverty
• Empower disadvantaged groups e.g. women
• Create employment
• Help existing businesses grow or diversify their activities
• Encourage new businesses
2.4.2. Can the “poorest of the poor” be targeted in these development objectives?
2.4.2.1.
The World Bank suggests that the poorest of the poor may not benefit from
microfinance services3 until other social services are provided (e.g. education,
health etc.). The very poor may not have adequate opportunities or skills to make
use of credit provided to them. It may not be possible to lend to them in the long
run unless they receive basic training on running a business, and have a minimum
level of health care.
2.4.2.2.
A study by Hulme and Moley4, suggests that there may even be unforseen
negative effects if the poorest are inappropriately targeted by MFIs. Their study
involved comparing the growth in borrowers’ income against a control group. It
suggested that financially sustainable institutions succeeded in reducing poverty of
the “middle and upper strata” of the poor. Clients that were very poor to begin
with, were worse off after borrowing. Their long term overall income did not rise,
as they struggled with the financial burden of repayment.
2.4.2.3.
If the poorest are targeted, there will be a limited source of donor funds for the
subsidies. Operating on such a basis means that more time and energy has to be
spent on ensuring that the money is directed to the most needy clients, in order to
ensure that the programs are having the greatest possible influence.
3
4
Microfinance Handbook, 1999, Washington DC, The World Bank
Finance Against Poverty, 1996, London, Routledge
13
2.4.3. Sustainable funding – the way of the future? Bodies like the World Bank and the
Asian Development Bank advocate that MFIs provide financial services in a sustainable
manner. The sustainability approach encourages institutions to cover their lending costs
and manage risks to return profits, similar to the principles of the established financial
services industry. The major advantages in this paradigm stem from the increase in
supply of microfinance services to the economically active poor, through the increased
investment by commercial lenders. This also allows savings institutions to mobilise
pooled funds on a sustainable basis. According to the World Bank, donor funding can
be freed up to support alternative social investment.
2.5. Funding sources: Donor vs Market
2.5.2. Donor funding has historically been the major source of funds for MFIs. This of
course has meant that the supply of microfinance services has been limited by the
amount of donor capital available. Listed below are some of the major donor
organisations involved in microfinance.
Box 2.4- CGAP Donors
Australian Agency for International Development
Belgian Administration for Development Cooperation
Canadian International Development Agency (CIDA)
Royal Danish Ministry of Foreign Affairs
Ministry of Foreign Affairs, Finland
Agence Française de Développement (AFD), France
Ministère des Affaires Étrangères (MAE), France
Kreditanstalt fur Wiederaufbau (KFW), Germany
Federal Ministry for Economic Cooperation and Development (BMZ), Germany
Society for Technical Cooperation (GTZ), Germany
Ministry of Foreign Affairs, Italy
Japan Bank for International Cooperation (JBIC)
Ministry of Foreign Affairs of Japan
Ministère des Finances, Luxembourg
Ministère des Affaires Étrangères, Luxembourg
Ministry of Foreign Affairs, Netherlands
Norwegian Agency for Development Cooperation (NORAD)
Royal Norwegian Ministry of Foreign Affairs
Swedish International Development Cooperation Agency (SIDA)
Swiss Agency for Development and Cooperation (SDC)
Department for International Development (DFID), UK
US Agency for International Development (USAID)
African Development Bank (AfDB)
Asian Development Bank (AsDB)
European Bank for Reconstruction and Development (EBRD)
International Fund for Agricultural Development (IFAD)
European Commission
Inter-American Development Bank (IDB)
International Labour Office (ILO)
United Nations Development Programme (UNDP)
United Nations Capital Development Fund (UNCDF)
United Nations Conference on Trade and Development (UNCTAD)
World Bank
Source: www.cgap.org/html/ac_members_donors.html
14
2.5.3. Market based funding: Given the great demand for microfinance that exists amongst
the poor, and the limited amount of donor capital available, some MFIs are seeking
capital through the established financial markets (either through commercial paper or
equity offerings). South America in particular has seen offerings like this. However, this
is difficult for all but the largest providers, as the information necessary for the capital
markets is often difficult to provide, and the required return on investments may be
unachievable. The issue of assessing different sources of funds is beyond the scope of
this paper.
2.6. Differences with established financial services providers: Microfinance
services tend to mirror, and provide many similar services to traditional finance products.
There are however many differences in the way these services are provided.
2.6.2. Decentralized structure: Microfinance organisations usually have an extremely
decentralised structure, as a result of serving communities over large geographic
distances, but with limited electronic communication facilities. The infrastructure is
generally weak, with a lot of the control lying with the people in small regional
communities. In most structures there is little communication between the units on a
day to day basis, as staff generally work on a local level providing the services to
clients. The loan staff usually have close contact with their clients. The fact that usually
loans are provided with very limited collateral, requires this closer interaction, to ensure
that the institutions can directly and effectively manage their risks.
2.6.3. Low loan and savings account sizes: Account sizes of the poor are naturally quite
small in comparison to established financial services providers, reflecting in part the
limited ability of the poor to use large volumes of money productively, or save large
volumes of money.
2.6.4. High expenses: The small size of the accounts, and the highly labour intensive
lending process result in high expenses for MFIs. High expense ratios are limited to
some extent by keeping very limited documentation on the services provided. It can
however make it difficult to track and analyse the performance of the portfolio.
2.6.5. Limited education and financial skills of clients: This problem often means that the
poor may not have the skills to make full use of the finance provided, or to manage it
properly.
15
Section 3: Is there scope for actuarial involvement?
3.1. Why would actuaries want to get involved?
Without a doubt, earning lots of money is NOT one reason to get involved in microfinance.
Most of the MFIs that might use actuarial services run bare-bones operations and do not
have the financial resources to pay for actuaries at commercially viable rates.
So why should actuaries get involved? In the authors’ views, it is so that we can play our
part in encouraging the development of poor communities to be financially self reliant. As
actuaries, we perhaps don’t see the impact of our work directly affecting the lives of people.
Here is one area, where our skills can help improve living standards of a group, perhaps
substantially.
3.2. Has there been actuarial involvement to date?
3.2.1. Current Involvement: There are not many actuaries involved in microfinance at the
moment. The only case of an actuarial body assisting an MFI that we are aware of, is a
case in Pune, India. This involved collaboration between an NGO Inter Aide (nongovernment-organisation), and the IAA / IA (International Actuarial Association /
Institut des Actuaires). They financed 2 French actuarial students for 4 months in Pune
to work with an actuary who was already working for InterAide on tariffs for a recently
launched health mutual for slum dwellers. This came under the Actuaries without
Frontiers initiative of the IAA, although the effort in setting up the sponsors was carried
out by the Institut des Actuaires in France.
16
BOX 3.1 The Inter Aide / Annapurna Pariwar programme in Pune, India
Inter Aide is a French trust, backed by funds from various private and institutional bodies. Its motto is to
“setup and follow up concrete sustainable development programs”.
In Pune and Mumbai, Inter Aide is assisting various NGOs with the provision of credit, savings and
insurance microfinance services to communities of urban slum dwellers. For this task, Inter Aide has
employed an actuary, François-Xavier Hay.
One of those NGOs, Annapurna Parivar in Pune had been providing savings and credit services for some
years. In 2001, due to a lack of financing capacity and professionalism, this organization was not able to
grow to meet the demand for its services. Inter Aide started to work with them on credit and savings,
giving management support, organisational support and some basic financial input. Based on discussions
with François-Xavier Hay, it was apparent that there was demand from the grass roots for more services to
be provided. In that year, one of the members of the community faced a severe heart complaint and needed
a relatively expensive operation (>Rs100,000). Her husband could not afford to pay for this with his
income – but attempted to raise the funds anyway by selling his main asset: the rickshaw he drove for a
living. His efforts were unfortunately in vain, and instead he was left facing financial ruin. Given this
extreme example, the local community members decided that they needed some risk management service
to help members finance unforseen health costs they may face.
The fact that an actuary was employed in this situation was key to the health insurance mutual being
thought of and set up. The additional fact that the actuary is working alongside the local community
enables the transfer knowledge of running the scheme to locals. The Institut des Actuaires sent 2 student
actuaries to assist with the financial evaluation and scoping stage of the project. Inter Aide expects to be
involved for 5 years in total, right from setup to the training of local staff to make sure the project can be
run autonomously.
The mutual has now started providing services. It offers coverage for about 15 relatively common causes
of hospitalisation in Pune, such as malaria, caesareans, pneumonia etc. It costs Rs50 per person per year,
and offers coverage up to a cost of Rs 5,000 per person per year. To avoid the problems of anti-selection,
there are sur-charges imposed where families only insure some members, where there are elderly family
members, and where there are alcoholics.
3.3.
Where can actuarial skills be used?
3.3.1. What is our skill set?
Actuaries are involved in various aspects of the financial services industry. Some of the
areas worked in are shown below in Box 3.2:
Box 3.2- What do actuaries do?
Valuations
Pricing
Product Design
Financial Management
Credit rating
Management Information System Design
3.3.2. Which of these skills can be used in microfinance? Listed below are some of the areas
where we think actuarial skills can be used.
3.3.2.1.Financial Management and product design: Basic knowledge about how to design
and monitor financial performance is not easy for people without a financial
17
services background. From discussions with François-Xavier Hay, the French
actuary in Pune working with Inter Aide, it appears that this is often the most
useful knowledge that an outside expert can bring to a scheme.
3.3.2.2.Pricing and design of insurance products: To date most developments in
microfinance have been on the lending side. Historically, actuaries have not been
as heavily involved in credit provision, as most other financial services. It is
perhaps to be expected therefore that we have not had a big involvement in
microfinance schemes. Some MFIs are expanding to provide insurance and
savings services to their product range. Actuaries have historically had much more
involvement with such products, and there will undoubtedly be more demand for
the skills if and when this happens.
3.3.2.3.Management information system design: MFIs have great difficulty in tracking
and storing data that can be used for scheme management purposes. Data is often
not computerised, and may not be set up in a useful way that can help with
assessing risk of default, risk accumulation by area etc. Actuaries can help in
assessing what should be tracked for management of the scheme.
3.4.
What can the Institute of Actuaries of Australia do to get involved in
microfinance?
3.4.1. Sponsor an MFI either locally, or internationally: As a professional body, if we
want to be involved in microfinance, one way would be to provide sponsorship to an
MFI to allow an actuary to work with them for some time. Funding will always be
difficult in these matters, and it would probably require at least some level of
commercial support. Paying for people’s time and effort is not easy given commercial
realities. Perhaps students / people without financial commitments might be interested
in volunteering some of their time. The ongoing nature of the schemes may mean that
the support will be needed for quite a long time until there is a transfer of skills.
3.4.2. Market ourselves to funding bodies such as aid agencies: In Australia, there is not
much knowledge or support of microfinance. Bodies like AusAID (the Australian
Government’s Overseas Aid programme) do however sponsor financial professionals
to work in developing countries to assist in the establishment of financial services.
Lobbying and explaining the worth of our skills may make it easier for actuaries to be
desired by the schemes. Other possible organisations to approach are the World Bank
and the Asian Development Bank.
3.4.3. Have a more active role in the IAA Actuaries Without Frontiers project: This is a
group that was set up under the IAA to encourage volunteerism amongst actuaries to
help spread our skills to regions where they are not used. So far, this is the only
actuarial group that is looking at microfinance that the authors of this paper are aware
of. It might be easier to seek involvement in microfinance through a global body, rather
than through local initiatives.
3.4.4. Seek to raise awareness amongst members of the Institute of the opportunity and
need for skilled financial professionals to help with these issues: Clearly, knowledge
amongst members about the role they can play in development is crucial for actuaries to
become involved in microfinance.
18
Appendix: An Interview with François-Xavier Hay of Inter Aide
Q: Who sponsored the project you are involved in and why?
FX-Hay: I am employed by Inter Aide a French Trust. We get funds from various private bodies as
well as institutional funders. Our motto is to “setup and follow up concrete sustainable development
programs”.
Institut des Actuaires helped us for the first "feasibility part" sending 2 actuarial students for 4
months. The project I am in charge of consists of providing microfinance technical support (along
with financial support) through a network of NGOs. The health mutual fund is a project within this
context.
·Q: When does it finish?
FX-Hay: We intend to setup this mutual fund in 5 years at a good autonomy level.
Q: What impact do you say you had on the project?
FX-Hay: Our impact is to improve the slum dwellers' livelihood, working with them on participative
projects like microfinance mutual funds, and individually with dynamic social follow up for the most
depressed families.
Keeping in mind this goal, an actuary in this context, brings techniques like a hydro engineer in
watershed programs would do. Micro finance/insurance can be as complicated as finance/insurance.
I think one big impact is education that is spread through actions.
Q: Are there any other areas you see actuaries using their skills?
FX-Hay: I guess any areas where actuaries are working in the formal corporate world. For example,
we are in the process of implementing quality circles-charts at the moment.
Q: What was your motivation in doing this?
FX-Hay: Typical actuarial job brings so much complexity to fewer and fewer well off
people, having mainly a 15% return on capital as a given target. Being part of
those, among the 5% of the highest payroll of the planet (not difficult) I
felt that my life was going in the wrong way.
Q: What have you personally got out of it?
FX-Hay: Some sense in my life and lot of extraordinary lessons from the people I
work with. I got also the conviction that this work is closer to what my
life should be, compared to what I was doing previously.
Q: How have the clients benefited from the project?
19
FX-Hay: They are not clients. They are partners or shareholders in this project. From my
experience that is the only way to benefit from something. A client gets a
temporary service. The goal is not to feed the slumdwellers. We intend to
share everything including the direction board seats, when the education
will be good enough.
Q: How do you suggest actuaries push the agenda of being involved with
the poor?
FX-Hay: We could share more about it in our professional meetings and forum. On the other hand, I
think It would be fantastic if the lessons we learn in this type of project would be studied in the “socalled” developed countries to improve there, the social situation and its future.
20
BIBLIOGRAPHY AND ACKNOWLEDGEMENTS
References:
“Discussion Paper BRIEFS, Distribution, Growth, and Performance of Microfinance Institutions in
Africa, Asia, and Latin America”, Cécile Lapenu and Manfred Zeller – International Food Policy
Research Institute.
“Getting the framework right : policy and regulation for microfinance in Asia” , Paul McGuire, John
D. Conroy and Ganesh B. Thapa. Brisbane : Foundation for Development Cooperation, 1998.
“The Microfinance Revolution: Sustainable Finance for the Poor”, Marguerite S. Robinson,
- International Bank for Reconstruction and Development: World Bank, 2001.
“Rural Finance; Issues, Design, and Best Practices.” ,Yaron, Jacob, McDonald P. Benjamin, Jr.,
and Gerda L. Piprek.- Environmentally and Socially Sustainable Development Studies and
Monographs Series 14. Washington, D.C.: World Bank, 1997.
“Microfinance as a regular commercial banking product”, The World Bank Group, November 1997,
Joselito S Gallardo, K. Randhawa, Orlando J. Sacay.
“Insurance as a microfinance product”, Mary Miller, Zan Northrip - Conference on Advancing
Microfinance in Rural West Africa, February 2000.
“Microfinance Handbook. An Institutional and Financial Perspective”, Joanna Ledgerwood - World
Bank, 1999.
“Finance for the Poor: ADB Microfinance Development Strategy” - Asian Development Bank, 2000.
“Health Insurance Services for Rural Households in Cambodia, Activity Report of Two Years of
Experimentation”, Christine Poursat and Pascale Le Roy - GRET 2001.
Internet References
Consultative Group to Assist the Poorest: http://www.cgap.org/
Microcredit summit: http://www.microcreditsummit.org/, The State of the Microcredit
Summit Campaign Report, 2001.
The Micro Banking Bulletin. http://www.mixmbb.org/en/
Microenterprise Results Reporting, 2000 -U.S. Agency for International Development, Office of
Microenterprise Development: http://www.mrreporting.org/Download/MRR2000Report.pdf
Grameen Bank Statistics: http://www.grameen-info.org/bank/supdates.html
Grameen Bank Programs: http://www.grameen-info.org/bank/index.html
21
BRI Statistics: www.bri.co.id/microbanking/ivp.asp
BRI Microfinance Programs: www.bri.co.id/microbanking/microbanking.asp
World Bank and microfinance: http://wbln0018.worldbank.org/networks/fpsi/rmfsme.nsf/
Asian Development Bank and microfinance: http://www.adb.org/Microfinance/default.asp
Microfinance Gateway: http://www.microfinancegateway.org/
“Hisory of Microfinance” Daniel J. Evans School of Public Affairs,, University of Washington:
http://www.evansuw.org/faccourses/andersoncl/pbaf599f/intro/hist1.html,
Inter Aide: www.interaide.org
Special Mention of Thanks:
We would like to make special mention of the following people who greatly enhanced our
understanding of the issues affecting microfinance institutions, and who have contributed greatly to
this paper:
François-Xavier Hay from Inter Aide
Indu Balachandran
Don Johnstone
Craig Thorburn, The World Bank
As always, any views presented, mistakes made, mis-representations, errors or omissions are the
authors’ own.